Bank Of America Stock: Set To Trade At A Discount (NYSE:BAC)

Bank of America Corporation (NYSE:BAC) has scheduled its 3Q-22 earnings report for October 17, 2022, and the bank is expected to show continued deterioration in asset quality, indicating larger credit provisions and loan losses.

Given the deterioration in the general economic situation since the publication of 2Q-22 earnings, I believe it is just a matter of time before Bank of America’s stock begins to trade at a discount to book value.

With difficulties worsening and no catalysts to warrant a higher value, Bank of America is best avoided before earnings.

Cyclical Bank Exposure, Deteriorating Asset Quality, Inflation Risk

Bank of America’s asset quality began to worsen in the second quarter as economic risks such as inflation, a more aggressive interest rate hike cycle from the central bank, and slowing economic growth increased. According to today’s jobs data, the U.S. economy added 263K jobs in September, down from 315K in August.

When I last reviewed Bank of America, I mentioned that fundamentals such as asset quality trends and slowing growth in the Consumer Bank were concerning. Bank of America’s credit provisions, in particular, increased to $523 million in the second quarter, a clear indicator that asset quality may be degrading more broadly amid a rising set of issues for the American consumer. In 2Q-22, approximately 78% of credit provisions were tied to Bank of America’s Consumer Business.

Consumer net charge-offs at Bank of America increased in the second quarter, indicating that a weakening labor market and sky-high inflation continue to weigh on the bank’s consumer credit division. Commercial net charge-offs remained modest at 0.03%, although this could change if the United States enters a recession.

Because inflation remains a major concern for consumers, I am concerned that retail enterprises and banks may face a wave of loan defaults as more and more people are forced to choose between paying their grocery bill and making a payment on their personal loans.

In August, inflation was 8.3%, and the rate for September is anticipated to be even higher. With inflation and economic trends straining customers, more of them may default on personal loans that banks like Bank of America were all too pleased to make a year ago. In other words, given the current economic backdrop of rising consumer prices and a cooling job market, investors should anticipate a significant increase in credit provisions in Bank of America’s third-quarter earnings presentation, as well as a general worsening in the bank’s asset quality.

All Of This Leads To A Discount To Book Value

An investment in Bank of America, at its heart, reflects cyclical banking exposure. When banks tighten their lending standards to limit default risks, it is a significant indicator that investors should avoid investing in the banking sector. In my opinion, the ultimate indicator that it is time to avoid cyclical banks is when their equities begin to trade at discounts to book value.

Bank of America, for example, has traded at a premium to book value when the Consumer Bank, which acts as a proxy for the American economy, performed well. Bank of America’s stock, on the other hand, traded at a discount to book value whenever severe economic disasters occurred.

The stock of Bank of America today trades at a 6% premium to book value, but the premium was significantly bigger at the start of 2022. I believe Bank of America’s stock will soon trade at a discount to book value, reflecting the bank’s weakening macroeconomic environment.

Why Bank Of America Could See A Higher Valuation

In my opinion, the only thing that may cause Bank of America’s stock to defend a premium book valuation is if a U.S. recession is avoided.

Given that the U.S. economy has already experienced two quarters of negative GDP growth, I believe the chances of this happening are extremely low.

If Bank of America’s asset quality improves and the bank announces an unexpected QoQ decline in credit provisions for 3Q-22, BAC may continue to trade at a premium valuation.

My Conclusion

Despite trading at just about book value, Bank of America is a value trap in my opinion, and I also believe we have reached a tipping point.

Major banks are likely to experience a continuation of 2Q-22 asset quality trends in the third quarter, giving the market a solid cause to discount institutions like Bank of America’s cash flows and profits prospects.

Bank of America’s 3Q-22 results will be out in around ten days, therefore purchasing the shares is out of the question for me. In fact, when the market adjusts to the prospect of a lengthier recession, I believe all major U.S. banks will begin to trade at discounts to book value once more.

If Bank of America’s credit provisions rise in 3Q, as I think, it might be interpreted as a warning sign that rougher times are ahead for the company and the broader U.S. banking sector.